Digital Currency Vexes Buy Side


Bitcoin’s bullish run since the beginning of the year has recaptured the attention of institutional investors, but it and other digital currencies still have ways to go before they’re a suitable investment for vanilla long-only investors.

The principal impediment for institutional investors to invest in digital currencies is the dearth of hedging instruments, according to Michael Moro, CEO of Genesis Global Trading and who participated in an industry roundtable during the Consensus conference in Manhattan.

“Until we get an institutional-sized derivatives model, whether futures or options, to hedge exposure, I think it will be difficult for folks in the long-only market to trade digital currencies,” he noted.

However, this has not held back some institutional investors, added his fellow panelists.

“If someone wanted to write a check for $10 or $20 million when I was setting up my dedicated digital currency fund a year ago, I would have told them to buy bitcoin,” said Brian Kelly, founder of asset management firm BKCM LLC. “I couldn’t do more with it because there was no liquidity. Now, $100 million would not be an issue whatsoever regarding liquidity.”

Kelly eventually would like to be in the position where it might take as long as a week to unwind a position in any of the top 15 to 20 digital currencies in which his fund invests. “So far, we have been able to get liquidity in a day,” he said.

Genesis Global Trading, which trades in the five most liquid digital currencies, has seen its client base changing in the past 18 months.

“Early on, it was Silicon Valley high-net-worth individuals and family offices,” said Moro. “It stayed that mostly stayed that way until early 2016 when the hedge funds started to play more actively in this space.”

Previously Genesis would average between $10 and $20 million in OTC trades per month, but Moro expects that to grow to six to ten times that amount in 2017.

“It’s not just the interest level that people want to discuss,” he said. “They are actively transacting and putting their money where their mouth is.”

Kelly also expects that Japan and South Korea will become a greater source of liquidity by January 2018. “In terms of retail forex traders in Japan, they trade $10 trillion a quarter,” he said. “The are the biggest traders in the world. I wouldn’t underestimate the liquidity that will come to this market now that Japan has opened up.”

The second impediment to institutional investment in the digital currency market is the custody arrangement once a trade’s completed, according to Moro. “As they are figuring out their investment thesis and how much capital they want to allocate to the asset class, the conversation always turns to ‘how do I hold this thing?”

“We have no prime brokers in this space,” added Kelly. “Funds like mine essentially have to self-custody.”

It’s cumbersome, but not an impossible, process that involves storing the digital currencies’ private keys on third-party digital wallets or in cold storage on air-gapped computers and geographically distributed thumb drives, he explained. “Once you do it, it’s not as difficult as it might seem. It’s more cumbersome than anything else.”

However, not all funds are capable of self-custody due to qualified custodian mandates, noted Marco Santori, partners at the law practice Cooley and who also took part in the panel.

“In general, funds can hold what they like,” he noted. “There are restrictions when it comes to hedge funds and restrictions when it comes to venture-capital funds. Whether you are providing custody for securities or some other general tangible asset, that defines your operation model.”

For those firms, which offer to act as custodian for digital currencies there are still a few legal issues those providers need to address for their clients.

Custodians who want to store their clients’ keys in multiple locations to protect them against natural disasters, political unrest, and other events is smart from a technical perspective, but it raises the question of which jurisdictional law and regulations will apply in cases of an insolvency or an involuntary bankruptcy, according to Santori. “These issues are not answered today.”

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